“We Are All Watching The Beads Of Sweat Forming On The Fed’s Forehead”

By Michael Every of Rabobank

Hawks Of A Feather Flock Together

The RBNZ went 50bps again yesterday, taking rates up to 3.00% as expected, and saying: “it remains appropriate to continue to tighten monetary conditions at pace to maintain price stability and contribute to maximum sustainable employment. Core consumer price inflation remains too high and labour resources remain scarce.” Scarce resources – as I noted yesterday. Remember those? Many don’t.

Moreover, the Reserve Bank showed no sign of backing off, adding that monetary conditions needed to continue to tighten until they are confident there is sufficient restraint on spending to bring inflation back within its 1-3% target range. Indeed, they remain “resolute in achieving the Monetary Policy Remit.” (All capitalised too!) Their forecast is now that RBNZ base rates peak around 4.1% in mid-2023, up from 3.9% before – but let’s call it 4%.

The Kiwis look to be canaries in the global monetary policy mine rather than on one of their solo failed-tightening cycles. Indeed, appalling inflation numbers in the UK –headline CPI hitting 10.1% y-o-y, seeing the press note ‘a 13% peak looks optimistic’– saw a surge in gilt yields and market expectations that BOE rates are going to have to keep moving higher, with the peak now seen at 3.75%. One more bad CPI print and that will no doubt be 4% too. So, two very different economies, and one broadly similar view on where rates may settle.

The FOMC minutes then made it three in one day. Nonetheless, there was less ‘Follow me!’ than was evident in the statement from New Zealand.

The Fed’s favorite core PCE price inflation measure was expected to decline to normal by 2024. Risks to their baseline projection for real activity were skewed to the downside. Consumer expenditures, housing activity, business investment, and manufacturing production were all seen as decelerating from the robust rates. Ebbing foreign economic outlook and a strong dollar were contributing to weaker external demand. Only the labour market was still seen as strong – even though that is a lagging indicator. Even so, the key message was that US growth below trend was fine if it helped reduce inflationary pressures.

For the hawks, “inflation remained unacceptably high….[and] inflationary pressures were broad based.” Indeed, “declines in the prices of oil and some other commodities could not be relied on as providing a basis for sustained lower inflation, as these prices could quickly rebound.” Oops, for those relying on that metric – as the head of OPEC was underlining yesterday. Moreover, “sizable additional increases in residential rental expenses” were likely to drive a rebound in inflation ahead. (‘OER misses’, as I have quipped before for the rare subset of economics and Frankie Howerd fans.) Overall, “there was little evidence to date that inflation pressures were subsiding,” and inflation… “would likely stay uncomfortably high for some time.”

For doves, there was a throw-away line that “the high cost of living was an especially great burden on low- and middle-income households.” (“Oh, it’s the MEEK! Oh, I’m glad they’re getting something, because they have a hell of a time.” – for the much less rare subset of economics and Monty Python fans.) But higher mortgage costs and unemployment aren’t a burden(?)

For hawks, inflation stemming from supply bottlenecks would take “considerable time” to be resolved, and some suggested full resolution would take longer than previously assessed (**cough** ‘In Deep Ship’ **cough**). Some felt even that by itself “could not be relied on” to resolve supply-demand imbalances driving inflation. So less demand was needed too.

As such, “moving to a restrictive stance of the policy rate in the near term” was appropriate in order to build the FOMC’s credibility, and from a risk management perspective: and rates would need to be kept higher “for some time” once having achieved that target. So, ‘Higher for Longer’ as the new mantra? Whocouldanooed?

Yet for doves, the Fed also noted the need to slow the pace of rate hikes “at some point”, as the market now leans more towards a 50bps move in September than another 75bps step – and which is our Fed Watcher Philip Marey’s call too: and for November and December, so 150bps more this year.

Some members also noted “the effects of policy actions and communications were showing up more rapidly than had historically been the case, because the expeditious removal of policy accommodation and supporting communications already had led to a significant tightening of financial conditions.” I am not sure which conditions they are referring to: certainly not higher bond yields, wider credit spreads, or lower stocks. Perhaps they were long crypto?

Perhaps the key dovish phrase was that some saw “there was also a risk that the Committee could tighten the stance of policy by more than necessary to restore price stability. These participants highlighted this risk as underscoring the importance of the Committee’s data-dependent approach to judging the pace and magnitude of policy firming over coming quarters.” By contrast, the BOE knows there is going to be a recession, and is carrying on regardless. The RBNZ also seems pretty committed.

In short, we are all back to data-watching, which is where we were before: and also watching the beads of sweat forming on the Fed’s forehead (and those of the doves/rates bulls?)

One cannot help but think that there is some significance in the RBNZ, BOE, and Fed all now flocking together towards a base rate around 4% and then staying there for “some time”.

Indeed, Philip notes in ‘Lost in Translation’: “While the minutes are yet another piece of evidence that the Fed has prioritized price stability over full employment, markets are likely to remain deaf to the Fed’s repeated attempts to explain how they want to approach the current outbreak of inflation…. The same crowd that thought that inflation was transitory, is now celebrating peak inflation and the coming of an early Fed pivot. However, what they don’t seem to get is that bringing inflation back to 2% is going to require patience, from the Fed and markets.”

However, patience is for the birds, it seems.